Pump and dump "Pump and dump" is a form of microcap stock
fraud that involves artificially inflating the price of an owned stock through false
and misleading positive statements, in order to sell the cheaply purchased stock at a higher
price.
Once the operators of the scheme "dump" their overvalued shares, the price falls and investors
lose their money.
Stocks that are the subject of pump and dump schemes are sometimes called "chop stocks".
While fraudsters in the past relied on cold calls, the Internet now offers a cheaper and
easier way of reaching large numbers of potential investors.
Pump and dump scenarios Pump and dump schemes may take place on the
Internet using an e-mail spam campaign, through media channels via a fake press release, or
through telemarketing from "boiler room" brokerage houses (for example, see Boiler Room).
Often the stock promoter will claim to have "inside" information about impending news.
Newsletters may purport to offer unbiased recommendations, then tout a company as a
"hot" stock, for their own benefit.
Promoters may also post messages in chat rooms or stock message boards urging readers to
buy the stock quickly.
If a promoter's campaign to "pump" a stock is successful, it will entice unwitting investors
to purchase shares of the target company.
The increased demand, price, and trading volume of the stock may convince more people to believe
the hype, and to buy shares as well.
When the promoters behind the scheme sell (dump) their shares and stop promoting the
stock, the price plummets, and other investors are left holding stock that is worth significantly
less than what they paid for it.
Fraudsters frequently use this ploy with small, thinly traded companies—known as "penny
stocks," generally traded over-the-counter (in the United States, this would mean markets
such as the OTC Bulletin Board or the Pink Sheets), rather than markets such as the New
York Stock Exchange (NYSE) or NASDAQ—because it is easier to manipulate a stock when there
is little or no independent information available about the company.
The same principle applies in the United Kingdom, where target companies are typically small
companies on the AIM or OFEX.
A more modern spin on this attack is known as hack, pump and dump.
In this form, a person purchases penny stocks in advance and then uses compromised brokerage
accounts to purchase large quantities of that stock.
The net result is a price increase, which is often pushed further by day traders seeing
a quick advance in a stock.
The holder of the stock then sells his stock at a premium.
Specific examples Jonathan Lebed
During the dot-com era, when stock-market fever was at its height and many people spent
significant amounts of time on stock Internet message boards, a 15-year-old named Jonathan
Lebed showed how easy it was to use the Internet to run a successful pump and dump.
Lebed bought penny stocks and then promoted them on message boards, pointing at the price
increase.
When other investors bought the stock, Lebed sold his for a profit, leaving the other investors
holding the bag.
He came to the attention of the U.S. Securities and Exchange Commission (SEC), which filed
a civil suit against him alleging security manipulation.
Lebed settled the charges by paying a fraction of his total gains.
He neither admitted nor denied wrongdoing, but promised not to manipulate securities
in the future.
Park Financial Group In April 2007, the U.S. SEC brought charges
against Park Financial Group as a result of an investigation into a pump and dump scheme
during 2002-2003 of the Pink Sheet listed stock of Spear & Jackson Inc.
Pump and dump spam Pump and dump stock scams are prevalent in
spam, accounting for about 15% of spam e-mail messages.
A survey of 75,000 unsolicited emails sent between January 2004 and July 2005 concluded
that spammers could make an average return of 4.29% by using this method, while recipients
who act on the spam message typically lose close to 5.5% of their investment within two
days.
A study by Böhme and Holz shows a similar effect.
Stocks targeted by spam are almost always penny stocks, selling for less than $5 per
share, not traded on major exchanges, are thinly traded, and are difficult or impossible
to sell short.
Spammers acquire stock before sending the messages, and sell the day the message is
sent.
Pump and dump differs from many other forms of spam (such as advance fee fraud emails
and lottery scam messages) in that it does not require the recipient to contact the spammer
to collect supposed "winnings," or to transfer money from supposed bank accounts.
This makes tracking the source of pump and dump spam difficult, and has also given rise
to "minimalist" spam consisting of a small untraceable image file containing a picture
of a stock symbol.
Short and distort A variant of the pump and dump scam, the "short
and distort" works in the opposite manner.
Instead of first buying the stock, and then artificially raising its price before selling,
in a "short and distort" the scammer first short-sells the stock, and then artificially
lowers the price, using the same techniques as the pump and dump but using criticism or
negative predictions regarding the stock.
The scammer then covers his short position when he buys back the stock at a lower price.
Regulation One method of regulating and restricting pump
and dump manipulators is to target the category of stocks most often associated with this
scheme.
To that end, penny stocks have been the target of heightened enforcement efforts.
In the United States, regulators have defined a penny stock as a security that must meet
a number of specific standards.
The criteria include price, market capitalization, and minimum shareholder equity.
Securities traded on a national stock exchange, regardless of price, are exempt from regulatory
designation as a penny stock, since it is thought that exchange traded securities are
less vulnerable to manipulation.
Therefore, CitiGroup (NYSE:C) and other NYSE listed securities which traded below $1.00
during the market downturn of 2008-2009, while properly regarded as "low priced" securities,
were not technically "penny stocks".
Although penny stock trading in the United States is now primarily controlled through
rules and regulations enforced by the Securities and Exchange Commission and the Financial
Industry Regulatory Authority (FINRA), the genesis of this control is found in State
securities law.
The State of Georgia was the first state to codify a comprehensive penny stock securities
law.
Secretary of State Max Cleland, whose office enforced State securities laws was a principal
proponent of the legislation.
Representative Chesley V. Morton, the only stockbroker in the Georgia General Assembly
at the time, was principal sponsor of the bill in the House of Representatives.
Georgia's penny stock law was subsequently challenged in court.
However, the law was eventually upheld in U.S. District Court, and the statute became
the template for laws enacted in other states.
Shortly thereafter, both FINRA and the SEC enacted comprehensive revisions of their penny
stock regulations.
These regulations proved effective in either closing or greatly restricting broker/dealers,
such as Blinder, Robinson & Company, which specialized in the penny stocks sector.
Meyer Blinder was jailed for securities fraud in 1992, after the collapse of his firm.
However, sanctions under these specific regulations lack an effective means to address pump and
dump schemes perpetrated by unregistered groups and individuals.